RBI warns NBFCs that chasing growth at all costs threatens financial stability

Mumbai: Reserve Bank of India governor Shaktikanta Das issued a strong warning to non-banks, particularly microfinance institutions and housing finance companies, for aggressively chasing “growth at any cost” that could pose a risk to the economy’s financial stability.

Das’s message to non-banking financial companies came as RBI’s monetary policy committee on Wednesday softened its policy stance to ‘neutral’ from ‘withdrawal of accommodation’, while keeping the key policy rate unchanged and reiterating inflation as a key risk.

“It is observed that some NBFCs are aggressively pursuing growth without building up sustainable business practices and risk management frameworks commensurate with the scale and complexity of their portfolio. An imprudent ‘growth at any cost’ approach would be counterproductive for their own health,” Das said in his monetary policy statement.

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Das also raised concerns about microfinance institutions (MFIs) and housing finance companies (HFCs) imposing usurious interest rates and frivolous penalties on their customers.

“These practices are sometimes further accentuated by what appears to be a ‘push effect’, as business targets drive retail credit growth rather than its actual demand. The consequent high cost and high indebtedness could pose financial stability risks if not addressed by these NBFCs,” added Das.

“The Reserve Bank is closely monitoring these areas and will not hesitate to take appropriate action if necessary,” he warned. “Self-correction by the NBFCs would, however, be the desired option.”

The ‘push effect’ refers to lenders pushing retail credit as per their business targets rather than actual demand. The consequent high-cost and high indebtedness could pose financial stability risks, if not addressed by these NBFCs, Das added.

“The push effect is confined to certain NBFCs. I am not generalising for the whole sector, which overall remains stable and has good health,” Das said at the post-policy briefing. 

He clarified that RBI does not treat banks and NBFCs as adversaries, and rather works closely with them in a spirit of cooperation.

“Given the wider purpose for credit inclusion served by MFIs and HFCs, we don’t expect a general tightening of guidelines for the sector,” said Anil Gupta, senior vice president, co-group head-financial sector ratings, ICRA. 

“However, given the cautionary statements by the regulator, there could be more regulatory scrutiny around the business models and risk practices of some specific NBFCs. If the regulatory concerns remain unaddressed, entity-specific action cannot be ruled out,” he said.

RBI deputy governor J. Swaminathan said the central bank’s messaging was targeted at a certain set of players, in particular segments that have seen outlier growth.

“The commentary from June-August numbers is that there are certain elevated slippages and little higher credit costs being seen in some segments. The messaging is targeted towards such NBFCs that are pursuing a high-risk, high-growth strategy and also to certain segments which are likely to get into stress in our estimate,” he said.

Stress building up 

Asking NBFCs to adhere to fair practices and adopt a sincere approach to customer grievances, Das also asked them to review their employee compensation practices to ensure they are not purely driven by sales targets. “Such practices may result in adverse work culture and poor customer service,” he said.

Das also pointed to the possibility of stress building up in unsecured loan segments such as loans for consumption purposes, microfinance loans, and credit card outstandings, and instructed banks and NBFCs to assess their exposures in these areas, both in terms of size and quality.

“Their underwriting standards and post-sanction monitoring have to be robust. Continued attention also needs to be given to potential risks from inoperative deposit accounts, cybersecurity landscape, mule accounts, etc.,” Das said.

RBI's warning comes after the central bank flagged certain similar risks by way of unprecedented growth seen in some unsecured loan segments such as personal loans and credit cards. In November last year, RBI increased the risk weights on certain categories of unsecured loans by 25 percentage points to 125%.

“RBI’s comments showcase that stress in unsecured lending segments such as credit cards and microfinance remains an ongoing theme and that RBI deems these segments important enough for specific attention,” said Shivaji Thapliyal, head of research (overall), YES Securities. “Unsecured ‘consumption’ loans also deserve monitoring, in RBI’s opinion, and these would include sub-segments such as consumer durable loans and BNPL (buy-now-pay-later) loans.”

Repo rate unchanged

On Wednesday, five of the six members of the monetary policy committee voted to maintain the repo rate—the interest rate at which banks borrow from RBI—at 6.5% for a tenth consecutive time. 

While all six members voted to change the policy stance to ‘neutral’—for the first time in two years, which could have pointed to a rate cut in December—RBI also highlighted the risk of sticky inflation and fluctuating food and fuel prices.

Also read | RBI may change policy stance, tweak growth forecast: Mint Poll

Das said that even as inflation had been brought RBI's 4% target, it needs to be kept under a tight leash. The monetary policy committee will therefore remain “unambiguously focussed” on aligning inflation to the 4% target while supporting growth, he said.

“The prevailing and expected inflation-growth balance have created congenial conditions for a change in monetary policy stance to neutral,” Das said in a statement. “Even as there is greater confidence in navigating the last mile of disinflation, significant risks—I repeat significant risks—to inflation from adverse weather events, accentuating geopolitical conflicts and the very recent increase in certain commodity prices continue to stare at us.”

The central bank maintained its estimate of consumer price index inflation for 2024-25 unchanged at 4.5%, but raised its projection for the ongoing third quarter (October-December) to 4.8% from 4.7%.

However, RBI slightly trimmed its inflation estimates for the following two quarters—to 4.2% from 4.3% for the January-March period, and to 4.3% from 4.4% for the first quarter of 2025-26.

RBI's rate-setting panel expects near-term inflation to remain high due to the base effect, with September and October numbers expected to come in higher.

That said, headline inflation is expected to sequentially moderate in the fourth quarter due to good kharif, or monsoon, crops, ample buffer stocks of cereals, and a likely good crop in the ensuing rabi, or winter crop, season. 

Rate cut: Not if, but when

While RBI remains confident about India’s growth story, economists expect demand conditions to weaken gradually, posing risks to the regulator’s growth estimates. 

The central bank projected real GDP growth rate for FY25 at 7.2%. It trimmed its growth outlook for the just-concluded second quarter (July-September) to 7% from 7.2%, but raised its expectations for the last final two quarters of the financial year—to 7.4% from 7.3% for the third quarter and to 7.4% from 7.2% for the final three months.

For the first quarter of FY26, RBI projected GDP growth at 7.3%, up from its earlier estimate of 7.2%.

While market experts had anticipated a rate cut later this year following the US Federal Reserve’s decision to lower its interest rate, the Street is divided over the timing. Some expect a rate cut in December while others see it happening only in February. 

However, several analysts anticipate a 50 basis point cut before the end of this financial year in March.

“A rate cut will be in the offing in future provided the data turns out to be acceptable,” said Madan Sabnavis, chief economist, Bank of Baroda. 

“Interestingly, RBI has projected inflation at 4.8% for Q3, which is the highest for the four quarters this year. This gives a sense that the earliest that we can see a rate cut will be in February, given the three major inflation risks highlighted by the governor: weather, geopolitics and global commodity prices,” he added. “The fact that growth is on a stable path provides comfort that there is no urgent need to lower the rates at this point of time.”

Rahul Bajoria, India and Asean economist at Bank Of America, expects RBI to act sooner.

“As December MPC (meeting) approaches, the growth slowdown in India will become apparent as inflation aligns itself to the 4% target. We expect repo rate cuts of 100 bp by December 2025, beginning December 2024,” he said. “If rate cuts are delayed or smaller, downside risks to growth would rise.”

Sensex breached the 82,000 level in morning trade before ending Wednesday 167 points down at 81,467.10 points, while the Nifty 50 gained nearly 500 points before closing slightly lower than Tuesday at 24,981.95. The 10-year bond yields eased 5 basis points after RBI’s announcement.